New Energy for Your Portfolio

By Mike Lawrence |  Jan 09, 2014

A U.S. boom in oil and natural gas production is fueling a wide range of potential opportunities for investors. But they may not be the ones you’d expect.

In 2012, the U.S. saw the largest expansion in domestic oil and gas production in the more than 150 years since it began drilling commercial wells.1 Improved technology that can unleash oil and gas from shale rock formations helped domestic oil output grow last year by a record 853,000 barrels a day, to the highest level in 17 years, according to the U.S. Energy Information Administration. And for natural gas, whereas the amount extracted from shale represented just 2% of the U.S. natural gas supply in 2000, it was 37% in 2012.

This U.S. energy boom comes largely thanks to the technology of "fracking," or hydraulic fracturing, coupled with horizontal drilling methods that allow for much faster, more efficient extraction of oil and natural gas. Fracking is controversial, with opponents noting that its methods — pumping a mixture of water, sand and chemicals under high pressure into source rock to crack it open, allowing gas and oil to flow — may result in groundwater pollution and other problems. But energy companies have continued to invest aggressively in this technology. And as processes have improved, natural gas production has become far more predictable. "We've gone from a high-risk, high-return market, with huge price volatility and swings in success of drilling rates, to a more stable current market that's largely about manufacturing," says Francisco Blanch, managing director and head of Global Commodity Research at BofA Merrill Lynch Global Research.

In contrast to the U.S. boom in production, Blanch notes, Europe has responded to rising global energy prices by reducing demand and turning to relatively less expensive sources of energy, such as coal. Although oil- and gas-harboring shale deposits in Europe (and possibly in China) are said to rival those in the U.S., overseas production has been slowed by a lack of advanced technology and capital. Consumers and businesses in the U.S. now pay $4 per million British thermal units, or MMBtu, for natural gas, compared with $11 to $12 in the U.K. and $18 in Asia.2

Although the prospect of what Blanch calls a "shale revolution" might suggest investment opportunities in producers of natural gas, he also notes that the bottomed-out prices in the U.S. may actually be adversely affecting these businesses, which include large energy companies that maintain significant natural gas operations as well as firms that focus exclusively on the fuel. Many stocks in this sector have, however, historically provided solid dividend income, and low valuations now could translate into long-term opportunities.

In the meantime, Blanch suggests several indirect approaches that might help tap the current U.S. energy boom.

  • Invest in energy-intensive U.S. businesses. Domestic manufacturers, particularly makers of steel, aluminum and automobiles, may benefit significantly from falling energy prices, which could reduce operating expenses, increase profitability and free up capital to invest in expansion and new employees. Domestic companies also are poised to save on transportation costs as many of them (particularly automakers) move factories back to this country. Rising labor costs in many parts of the world have made emerging markets less competitive.

    Another area to look at may be the U.S. petrochemical industry, which has largely switched from oil to natural gas for feedstock used to make chemicals such as ammonia, a vital ingredient of fertilizer. Those cheaper chemicals serve as economical raw materials for everything from auto manufacturing to farming and household goods, and can now be exported at globally competitive prices.
  • Consider providers of consumer goods and services. According to the U.S. Energy Department, natural gas home-heating prices have fallen 21% in New England and 25% in the mid-Atlantic during the past five years. Those savings leave consumers with more discretionary income, and as they spend less on utilities, they're able to spend more at restaurants and on electronics, travel, and a host of other products and services.
  • Look at transportation companies and retailers that manage large fleets of delivery trucks. Such businesses are exploring options for converting from diesel fuel to liquefied and compressed natural gas. Meanwhile, railroad companies are experimenting with gas-powered locomotives.
  • Think beyond stocks. Master limited partnerships, or MLPs, can help investors diversify within the energy sector, and they bring potential tax advantages (and risks) as well. Energy MLPs are typically offered by pipeline operators whose profits are based more on the volume of natural gas transported than on the price of the gas itself.

What's Next for Natural Gas?

Today's investing landscape could shift if the U.S. eases restrictions on selling surplus natural gas overseas. A Department of Energy study released last December suggested that increased exports could provide a broad boost to the economy. But it would likely raise U.S. prices for the fuel, and that worries groups such as America's Energy Advantage, a coalition of energy-dependent companies. At the same time, however, issues around the potential environmental damage caused by fracking could intensify and may need to be resolved one way or the other. If such concerns keep natural gas production and prices at current levels, "that would be a negative for U.S. gas-producing companies but a plus for gas-consuming companies and consumers," Blanch says. "North America has become natural gas-independent, and that's a big net positive for the economy on all sides." That makes this an ideal time to consider which investments might benefit most from these factors during the next five years.

1 U.S. Energy Information Administration as of May 2013

2 BofA Merrill Lynch Global Research, 2013

Any information presented in connection with BofA Merrill Lynch Global Research is general in nature and is not intended to provide personal investment advice. The information does not take into account the specific investment objectives, financial situation and particular needs of any specific person who may receive it. Investors should understand that statements regarding future prospects may not be realized. Due to the time-sensitive nature of the content and because investment opinions may have changed since the time any comments were made by research analysts, the latest BofA Merrill Lynch Global Research investment opinion and investment risk rating for any particular security discussed should be reviewed, including important disclosures, before making an investment decision. Under the global research settlement, BofA Merrill Lynch Global Research bears no responsibility or liability with respect to independent research selected by the independent consultant and made available by Merrill Lynch. Merrill Lynch clients should understand that they assume full responsibility for any trading decisions they make based upon independent research ratings or reports provided pursuant to the global research settlement.

Past performance is no guarantee of future results.

Investments focused in a certain industry may pose additional risks due to lack of diversification, industry volatility, economic turmoil, susceptibility to economic, political or regulatory risks and other sector concentration risks.

Investments in securities of Master Limited Partnerships involve risk that differ from investments in common stock, including risks related to limited control and limited rights to vote on matters affecting the MLP.


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